Qualified Mortgage Debt-to-Income and Cash Reserves

ISSUE/INQUIRY

If a borrower’s debt-to-income ratio is over the Bank’s guidelines but the borrower has significant liquid reserves, is there a way, within the QM requirements of Regulation Z, to consider the reserves in the DTI ratio calculations?  Can liquid asset reserves be considered in the income calculation in any way?

RESPONSE SUMMARY

In determining a consumer’s ATR or whether a loan qualifies as a QM, a lender must consider a number of factors, including such assets as cash reserves. In calculating DTI, however, income is generally limited to wages and salaries, though income and payments from other sources may also be considered, if they can be verified and documented. With respect to investments and trusts, interest and dividend income would be considered in calculating the DTI, but not the investments themselves. The DTI ratio must be at least 43 percent for loans qualifying under the General QM standards, but there is no DTI ratio for loans covered by the Small Creditor QM standard.

RESPONSE DETAIL

Introduction

A lender might be willing to make a loan to a consumer who has a debt-to-income ratio higher than the 43 percent allowed for Qualified Mortgages, when the cash reserves indicate a strong ability-to-repay. The question here is whether the cash reserves might in some way be included in the calculation of income.

Ability-to-Repay

Regulation Z requires lenders to consider at least eight factors in the underwriting of closed-end consumer loans secured by a dwelling:

• Current or reasonably expected income or assets
• Current employment status
• The monthly payment on the covered transaction
• The monthly payment on any simultaneous loan
• The monthly payment for mortgage-related obligations
• Current debt obligations, alimony, and child support
• The monthly debt-to-income ratio (“DTI”) or residual income
• Credit history. 12 CFR §1026.43(c)(2).

These are called the “ability-to-repay” or “ATR” rules. The value of assets is considered in evaluating a consumer’s ATR, though not that of the property securing the loan. In the present case, this means that the cash reserves of the consumers would be considered in determining whether the ATR standards were fulfilled. The Bank must also consider DTI or residual income in calculating an applicant’s ATR, but there is no specific DTI or residual income thresholds. Official Interpretations, ¶1026.43(c)(2)-4.

Qualified Mortgage

Mortgage loans which satisfy specific underwriting and repayment standards are “Qualified Mortgages” or “QMs.” A mortgage loan which qualifies as a QM is given a safe harbor or a rebuttable presumption (for higher-priced loans) that the ATR standards have been fulfilled, thus protecting the creditor from borrowers’ claims that they were given mortgage loans they could not afford or did not qualify for.

There are three types of QM loans:

• General QMs
• Temporary QMs (same as General QMs, but eligible for purchase or guarantee by Fannie Mae or Freddie Mac, the government-sponsored enterprises [“GSE”], or for insurance or guarantee by certain federal agencies
• Small Creditor QMs (for lenders with less than $2 billion in assets, originating not more than 2,000 first-lien mortgage loans, and with more than half of their mortgage loans made in rural or underserved areas)

It should be noted that, effective January 1, 2016, the number of first-lien mortgage loans that can be originated under the Small Creditor QM standard increased from 500 to 2,000.

In order to be given General QM status, a mortgage loan must comply with the following requirements:

• No negative amortization
• No interest only or balloon loans (with certain exceptions)
• No term exceeding 30 years (again, with certain exceptions)
• No temporary financing
• Income and financial resources must be verified
• Monthly payments calculated based on the highest payment that will apply in the first five years
• Total debt-to-income ratio cannot be more than 43 percent
• Total points and fees cannot exceed three percent of the total loan. 12 CFR §1026.43(e),(f).

Qualified Mortgage DTI

To qualify as a QM, there must be DTI ratio of no more than 43 percent. The ratio of a consumer’s total monthly DTI is determined in accordance with the standards in Appendix Q to Regulation Z. 12 CFR §1026.43(e)(2)(vi)(A).

Under the rules of Appendix Q, a consumer’s income is limited in most cases to salaries or wages. Income from other sources may also be considered, provided that it is properly verified and documented:

• Overtime and bonuses
• Automobile allowances and expense account payments
• Earnings by consumers considered “self-employed” (e.g., sole proprietors or owners of corporations, subchapter S corporations, or partnerships)

Non-employment related income may also be considered:

• Alimony, child support, or maintenance income
• Military, government agency, or assistance program income
• Investment or trust income

With respect to investment or trust income, interest and dividend income may be used so long as tax returns or account statements support a two-year receipt history. This income must be averaged over two years. The definition of investment or trust income does not include the investment itself. Appendix Q to Part 1026, II. B.

Other Qualified Mortgage DTI Rules

The DTI threshold for Temporary QMs is set by the GSE or federal government agency purchasing or guaranteeing the loans, but the 43 percent DTI ratio does not have to be complied with.

Small Creditor QMs do not have specific DTI thresholds.

Conclusion

Cash reserves such as deposits are important factors in determining whether ATR standards are fulfilled or whether a loan qualifies for the QM safe harbor. They are included in the calculation of income only to the extent that they generate interest.

This entry was posted on Monday, January 4th, 2016 at 2:00 pm.